Experienced Forex traders have probably noticed that there is occasionally a slight discrepancy between quotes for a given financial instrument displayed by different brokers. Aside from possible manipulation by brokers, this happens as a result of temporary delays in supplying quotes, quote smoothing, etc. The objective of an arbitrage operation is to take advantage of these discrepancies. The trader places a buy order with a broker that has a lower price and simultaneously places a sell order for the same value with a broker that shows a higher price. The trade is executed when the profit that can be obtained from the difference in the quotes is greater than the expenses incurred in the trade (ie the margin and the commission paid to both brokers). This operation is known as classic (two-legged) arbitration. The main advantage of classic arbitrage is the absence of risk and drawbacks. If one broker’s quotes always lag behind another broker’s quotes, it makes more sense to apply one-leg arbitrage, where trades are placed only with the lagging broker. The advantage that one-leg arbitrage has over classic arbitrage is higher profit potential; the downside is that this strategy involves drawdowns.
If we study the reasons behind the trading situations that make Forex arbitrage possible, we will see that in most cases they are caused by a delay in a broker’s market quotes relative to the more timely quotes from another runner. Delays occur for a number of reasons: the amount of time it takes for a quote to be transmitted from a liquidity provider through a broker’s server to your trading terminal may be longer for some brokers; As the quotes pass through the brokers, they may undergo changes such as filtering, smoothing, etc. As a result, when a security goes through significant price movements, the security quote you see in your trading terminal lags behind the actual market quote provided by liquidity providers. If the gap between the two quotes is wide enough to cover your trading costs, you can place an order through the lagging broker, with the aim of capturing the difference between the lagging quote and the broker’s actual quote with a lower quote. fast. In that case, you will have a statistical advantage over other traders. If the advantage is used properly, it is possible to achieve stable growth in profitability.
It should be noted that, with one-leg arbitration, it is completely unnecessary to cover your open position with the second (faster) broker as you would with the classic arbitrage strategy. There are two reasons for this: the profit will accrue to your lagging broker anyway, and the hedging will result in higher trading fees in the form of spread and commission that you will have to pay to the second broker. This type of unhedged arbitrage is known as single-leg arbitrage.
It should go without saying that the successful application of Forex arbitrage requires access to a source that provides quotes that are not delayed. You can use a broker with a faster source of quotes. A more reliable alternative involves the use of market quotes provided by a large bank or broker, for example LMAX or Saxobank.
The number of opportunities for arbitrage trading can vary widely from broker to broker, from dozens per day to just a couple per month. It depends on the degree to which quotes from a given broker lag behind actual market quotes.
We can conclude by dismantling a popular myth that is often expressed on the Internet. According to a firmly held opinion of some, there is no point in engaging in arbitrage trading, because brokers will not transfer your arbitrage profits to you. They can do this because commercially available arbitrage advisers execute lightning-fast trades that are bound to alert brokers to arbitrage activity. In addition, almost all brokers require a minimum waiting time between buying and selling a position, usually no less than 1-3 minutes. The stipulation falls under the brokers’ terms, and brokers have the right to cancel all trades that do not comply with their trading terms. However, arbitrage trades do not have to be executed instantly. If you increase the waiting time of your position, you should not have problems with your broker. In our own experience, if you wait at least 10 minutes before exiting your position, you will have no problem closing it.
Let me explain why arbitrage trading can still be profitable even when there is a lag time between buying and selling a position. You always have a small advantage when the price is delayed and you place an arbitrage order. It is impossible to say where the price will go after the price spread disappears, but if your trading volume is large enough, then half of your trades, regardless of subsequent price movement, will be profitable, while you you will lose money. in the other half. That way, when your trading volume is significant, the gains and losses incurred during price movements after the spread disappeared will offset each other, leaving you with a small advantage. When this advantage is cumulative, it will ensure stable growth in profitability. Essentially, the increase in the holding period between entry and exit of your position will lead to an increase in the dispersion in your profitability graph (which will be reflected in the increase in withdrawal from the account, something that should be taken into account when choosing the lot size), while the average profitability of your trades will remain unchanged. Note, however, that this is only true when you trade a lot, as you have the law of large numbers working for you.
The result is that Forex arbitrage strategies remain a useful and highly profitable way to invest your money.